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Business Insurance
Friday, June 12, 2015 - 02:16
Global imperative

Risk management and risk transfer must work together to make organisations resilient, as firms become more exposed to major disasters and subsequent business interruptions as a result of their increasingly complex global networks. Traditional property damage/business interruption policies were never designed to meet the risks faced by organisations today, and the business interruption insurance market has not kept pace with these rapid changes, according to Marsh, a global leader in insurance broking and risk management.

In a new Marsh Risk Management Research report, the firm highlights how the limitations of existing business interruption insurance, including gaps in cover and inaccurate valuations, are resulting in less than optimal coverage for clients and makes the case for insurance modernisation.
Based on concerns raised by colleagues, clients, loss adjusters, lawyers and insurers, the report focuses on five core areas where Marsh believes improvement is required: insured values; indemnity periods; wide area damage scenarios; supply chain; and claims.
Caroline Woolley, Global Leader of Marsh’s Business Interruption Centre of Excellence, commented: “A property damage event remains one of the major exposures any company can face, and business interruption is one of the main insurances purchased. Business interruption policies, however, have done little to evolve since the middle of the last century.
“The insurance industry needs to acknowledge the shortcomings of existing business interruption cover and build a better solution for buyers. This report is Marsh’s contribution to the debate as we seek to improve existing solutions and reshape the industry to address insurance buyers’ evolving needs.”
Five issues were considered in the report:
• Getting the values right.
• Setting the indemnity period.
• Ensuring BI claims are paid in wide area damage scenarios (natural catastrophe risk).
• The limitations of supply chain cover in PD/BI policies.
• Optimising claims settlement.

Getting the values right

“Getting the values right is critical for all parties,” says Marsh, “and, while taking the time to calculate correct declarations is recommended, we are perhaps at a point where an alternative approach should be considered. Businesses are obliged to submit detailed annual accounts to legislative authorities, and an alternative underwriting approach based on published values would avoid many of the errors encountered.”
As with all types of insurance, ensuring the values declared are accurate and provided in accordance with the policy definition is critical in the placement of PD/BI cover. The penalties for getting the values wrong can be significant, with the application of an averaging provision reducing recovery proportionally, and, even with the protection of a declaration-linked policy (133.3% values uplift), there is the potential for insurers voiding cover entirely.

Setting the indemnity period

The maximum indemnity period (MIP) is the period for which insurers will indemnify the claimant for financial loss arising from an insured event. In contrast to US gross earnings (GE) policies, gross profit policies require the declaration of a fixed MIP at placement. This period should be adequate for the business to reconstruct and recover trading and profit levels to those that would have existed had the loss not occurred.
The importance of taking the time to assess and set appropriate indemnity periods is being recognized by more businesses, and working with brokers and insurers on business-specific scenarios is an effective mechanism in crafting the right cover. In establishing realistic scenarios it is also important to consider, not only external factors, but also existing business continuity planning. It is vital to understand that the indemnity period is for loss of gross profit and/or increased costs.
Profit may be protected through mitigating actions, but those actions may attract increased costs, for which a suitable MIP is required.
An alternative tactic, however, may be to adopt the US gross earnings approach, whereby the MIP is not a set time period, but rather the time taken to reinstate (however long that might be) plus a fixed recovery period. This can be valuable for complex businesses with specialist equipment, although care should be taken to ensure that the post-reinstatement recovery period is maximized (90 days is often the standard limit provided).

Comments Marsh, “Indemnity periods can only be accurately set with detailed pre-loss work, and, while the open-ended US earnings approach should be commended, the limited post-reconstruction recovery periods are less than ideal. Two changes might be considered: firstly, the option to commence the calculation at either the date of the physical loss or damage, or at the time when the business begins to suffer a loss of revenue; and, secondly, the provision of an unlimited MIP underwritten on the basis of two years’ exposure. This will enable insurers to be confident of maintaining premium levels, and will ease insurance buyers’ concerns with regard to underestimating exposure.

Wide area damage

Insureds must not overlook the potential extent of damage, as for example in a natural catastrophe event. On average, 64% of total losses in the US are insured, which is actually a large percentage compared to other parts of the world (for example, in Europe, the figure is only 16%; and, in Asia, less than 1%). There are many reasons for such a shortfall, including conscious decisions not to insure, or industry standard exclusions (such as nuclear). Emerging risks can also be to blame, for which no insurance has yet been sought (for example, interruptions caused by natural catastrophe events that affect the suppliers of suppliers hidden in the chain).
Companies wishing to avoid the possibility of a reduced recovery in similar circumstances should be advised to engage insurers and negotiate wordings appropriate to their exposures. There are different strategies organizations can employ to address the “wide area damage” wordings issue, including a consideration of the trends clause, denial of access/loss of attraction clauses, and potential policy endorsements.
“The impact of a punitive application of the “but for” rule remains a threat to buyers in a wide area damage scenario that does not reflect well on the industry,” says Marsh. “We echo the comments in the 2012 CILA report that “the market needs to develop a wording that is in line with its intentions and that goes further to meet policyholders’ requirements and expectations.”

Supply chain risks

A typical business structure usually incorporates a complex web of suppliers and customers that often spans the globe. As a result, the landscape of risk changes dramatically; the variety of potential events and interruptions faced is vast. Traditional PD/BI insurance policies were not developed to cope with such exposures, and, as demonstrated below, do not offer the protection required in today’s market. But there are alternative solutions available. The insurance industry recognizes that the provision of suppliers’ extensions is, on its own, not a comprehensive solution to the severity of supply chain risks faced by a large number of organizations. More detailed information on supply chain risks is required before informed decisions on the need for alternative risk transfer can be made.
“In many ways, the industry response to increasingly complex supply chain exposures has been commendable,” says Marsh, “with the development of non-damage policies and a small number of carriers providing cover for all, not just primary, suppliers. Full supply chain cover should, however, be the rule, not the exception, and providing non-damage options within the policy framework (at increased premium) provides an easier option than choosing a new policy.

Claims
The assertion in a 2014 AIRMIC (the UK association for risk and insurance management professionals) publication, that “large claims are being contested far more than previously” should be a cause of real concern, says Marsh. Pre-loss claims scenario reviews will always be useful and agreed methodologies will help.
The claims promises being offered in respect of early interim payments are welcomed; however, the universal applications of claims preparation clauses ensures that all policyholders can access professional claims preparation resources, and that claims are presented in a manner that allows for efficient and timely settlement.

About Marsh
Marsh is a global leader in insurance broking and risk management. Marsh helps clients succeed by defining, designing, and delivering innovative industry-specific solutions that help them effectively manage risk. Marsh’s approximately 27 000 colleagues work together to serve clients in more than 130 countries. Marsh is a wholly owned subsidiary of Marsh & McLennan Companies (NYSE: MMC), a global professional services firm offering clients advice and solutions in the areas of risk, strategy, and people. With 57 000 colleagues worldwide and annual revenue exceeding US$13 billion, Marsh & McLennan Companies is also the parent company of Guy Carpenter, a global leader in providing risk and reinsurance intermediary services; Mercer, a global leader in talent, health, retirement, and investment consulting; and Oliver Wyman, a global leader in management consulting. Follow Marsh on Twitter @MarshGlobal, or on LinkedIn, Facebook and YouTube.

Copyright © Insurance Times and Investments® Vol:28.6 1st June, 2015
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